President Biden’s Tax Proposal’s Impact on Capital Gains Tax Planning
On April 28, 2021, President Biden’s “Fact Sheet: The American Families Plan” was released and contained several proposed tax law changes. The provisions were further explained by the Department of the Treasury’s Green Book released on May 28, 2021, with significant changes to long-term capital gains.
Under President Biden’s tax reform section, the Fact Sheet says, "households making over $1 million will pay the same 39.6% rate on all their income, equalizing the rate paid on investment returns and wages." The Green Book further explained this equates to 43.4% after the inclusion of the net investment income tax (39.6% + 3.8%) if the top ordinary income rate is increased from 37% to 39.6%. Therefore, capital gains and qualified dividend income for the affected taxpayers will be subject to this higher rate.
Consider the following tax strategies when planning for the changes:
Capital Loss Harvesting at Year-end — Capital assets with unrealized loss can be sold to generate a capital loss to offset capital gains within the same tax year. Be mindful of the wash loss sale rules where the loss will be disallowed for tax purposes if the identical asset (e.g., publicly traded stock) is repurchased within 30 days before or after the sale. It may be worthwhile to review the capital loss carryover from prior year tax returns.
Installment Sale — The installment sale method permits capital gains to be recognized as cash is received on the payment of the promissory note from the sale of properties. Inventory properties are not eligible. Consideration should be made for the following:
- Determine if any part of the gain is subject to depreciation recapture income. The recapture income must be recognized in the year of sale and may be taxed at the ordinary income rate.
- Project out the gain and tax by year based on the length and terms of the installment note.
- Elect out of an installment sale method to accelerate income into a lower tax bracket year.
Qualified Opportunity Zones — The spirit of the law was to encourage investment in designated distressed communities (qualified opportunity zones) by providing federal income tax benefits to taxpayers who invest new capital in businesses and real estate (construction and renovation) located within qualified opportunity zones through a QOF (qualified opportunity fund).
Eligible taxpayers may defer capital gains generated from a sale of property to an unrelated property by making a cash investment in a QOF within 180 days from the date of the sale. The capital gain is deferred until 2026 with a potential 10%-15% statutory cost basis step up. In addition, the post-acquisition gain is permanently excluded if the taxpayer holds the QOF investment for at least 10 years.
Gifting Appreciated Properties to Charities — Under the current law, the amount of charitable deduction is the fair value of the capital asset if the asset was held for more than one year. There are a few exceptions where the deduction is limited to cost basis, such as (i) contribution to private nonoperating foundations and (ii) using the 50% adjusted gross income limit instead of the 30% limit.
Income and Estate Planning — The proposal includes a limit of 1031 like-kind exchange gain deferral to $500,000. The Green Book increases this limit to $1 million for married filing joint individuals. This change is effective for exchanges beginning after December 31, 2021. The excess gain will be taxable in the year of the exchange. Careful income and estate planning steps should be taken jointly to review the current ownership of real estate.
If you have questions about minimizing your capital gains tax exposure based on the new legislation and when timing should be made for this change, reach out to our tax experts.